WeWork, And The Problem With High Valuations in Tech

Bloated valuations in the tech sector isn't a new phenomenon. But investors aren't having it anymore.
WeWork, And The Problem With High Valuations in Tech
Image credit: WeWork website
WeWork's office in Missouri
Entrepreneur Staff
Deputy Associate Editor, Asia Pacific
5 min read

WeWork, Wall Street’s latest darling, and its initial public offering, continued to crash and burn after its founder, Adam Neumann, stepped down on Tuesday, pressured by shareholders.

Neumann, the long-haired, leather-jacket wearing, tequila-loving Israeli, had once envisioned riding the skyrocketing popularity of WeWork to the end of the line with a more than multi-billion dollar valuation when it was listed, but his dreams crash-landed after the company took a massive valuation haircut.

Valued at $47 billion privately by investment bankers as early as January, the company had to slash its market value to as low as $15 billion after investors raised concerns about WeWork’s mounting losses.

Understandably burnt by Uber and Lyft’s IPOs earlier this year – both of which were also reporting losses consistently up until that point – the investing community was grew increasingly wary of WeWork’s potential to perform in public markets, with the final blow coming after SoftBank, which owns a third of the company, withdrew its support, saying it would have to take a massive writedown if WeWork was to push ahead with its IPO at a $15 billion valuation.

 

The problem with high valuations

Tech startups, especially ones that are already well known before they hit the public markets, are often valued at more than what they are worth. That has always been the case, and for a long time, no one minded it because most people bought the brand, or the name, instead of the company’s growth or investment return potential, anyway.

“People assume that these investors are very sophisticated groups that know everything. They don’t. To a certain degree, they invest like young children playing soccer – they all follow the ball. These investments tend to get very crowded a result. And then who else do you sell it to?,” says Marty Wolf, president and founder of martinwofl M&A Advisors, an investment advisory firm.

The biggest problem when a big name company decides to go public, but has a weak balance sheet, as was the case with Uber and Lyft, is that it invariably has to take a valuation cut before, or after its IPO. Uber saw how Lyft fared in public markets, and decided to bring down its own valuation to avoid the share price dive.

Investors obviously dislike voluntary valuation snips because it devalues the stake they hold in the company, just like in the case of WeWork and SoftBank. And then, they either exit, creating a bad rep for the company, or withdraw support, like SoftBank did, causing other potential investors to become skittish.

“Our concern here is that this pattern will create uncertainty for investors and companies seeking to go public in the near future. While there is a rational explanation for why many of these companies have crashed after their market debut, there is still a psychological factor embedded in market behavior,” says Chip Meakem, cofounder of Tribeca Venture Partners, a VC firm.

 

Who’s to blame?

“In the board rooms, behind closed doors, there is an incredible, high stakes game of head-on chicken with VC investors that sit on boards and their management teams where VCs need to meet their return profiles for their fund’s LPs, and thus can’t give the management teams more time to figure out how to properly manage a business. The investment bankers initially sat there quietly watching as they’re brokers trying to make as much money as possible, and therefore just want to make sure a transaction happens.

Then, after Uber and Lyft, investment banking reputations took a big hit and finally, for the first time, bankers are saying nope, we just can’t just make those valuations you need for your investors work and we have to slash valuations – Oh hey, WeWork!,” says Alex Song, chief executive officer and co-founder of Innovation Department, a tech-powered startup studio.

A recent CNBC story said that SoftBank chief executive officer, Masayoshi Son’s optimism in WeWork’s growth potential, and a lack of dissenting viewpoints also led to the company being overvalued.

“Public markets are making a clear distinction between proven, sustainable business models, and those still in doubt, like Uber. The market is acting rationally. Not all tech IPOs have crashed and burned, but rather those companies where skepticism of their underlying business model remains high,” says Meakem with Tribeca Venture.

Adding to WeWork’s miseries were also fears of a recession on the horizon, and a global economic slowdown.

“With the economy and financial markets giving off late cycle signals, there appears to be a shift away from growth at any cost, toward value,” says Charley Moore, chief executive officer of Rocket Lawyer, a legal technology company.

 

But why are people still talking up famous unicorns seeking to list on the stock exchange, even though they are loss-making?

“Consumers and investors are eager to find the next billion dollar company with a huge outcome for all constituents. This is as much of a psychological chase as a financial one which is why we are still talking about it,” says Meakem.

The recent spate of negative headlines coming out of global markets have also either pushed investors to the sidelines, or forced them to explore investments in avenues other than public markets.

“Investors tired of talking about the trade war with China, Chairman Powell and the president,” says Marty Wolf.

 

 

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